The Other Coca-Cola

Although most of you reading this are probably already aware of this fact, most people in the world are not: Shareholders of The Coca-Cola Company (KO) that buy a bottle of Coke off the Piggly Wiggly aisle in Atlanta are not entirely buying a product in they own. The syrup inside the bottle is entirely owned by Coca-Cola. But the bottle, or can, itself is produced by the The Coca-Cola Bottling Company, which has the ticker symbol: COKE. Every day, there are people intending to buy Coca-Cola–the one with the 50+ years of dividend increases–and inadvertently enter the intuitive ticker symbol COKE and purchase the bottling company instead.

Now, the history of Coca-Cola bottling contracts and rich families that have been in charge of bottling over the years is worthy of its own post–but the end result is that the heirs of J.B. Harrison control 91.8% of the voting stock even though they only own 23.1% of the outstanding stock because of a B share arrangement that gives each B share 20x the voting power of the hoi polloi like us that would have to buy the A shares.

The Harrison family has built a formidable distribution network that spans the states of North Carolina, South Carolina, West Virginia, Alabama, Mississippi, Tennessee, Kentucky, Virginia, Pennsylvania, Florida, and Georgia. When you buy a share of Coca-Cola Bottling (COKE), you are really buying an ownership interest in the company that supplies the plastic, glass, and aluminum to the syrup and then gets them to retail locations in the above mentioned states. The company COKE makes as much profit in a year as the syrup concentrate firm Coca-Cola (KO) makes in two days.

The bottling company is an inferior business to the syrup maker KO. When Coca-Cola (KO) invests a dollar of retained earnings for future growth, about $0.28 in each dollar flows to shareholders as profits. With COKE the bottler, a whole lot of cash must be put to use for each incremental gain in profits. It makes $50 million per year in profits while generating $2.5 billion in revenue. For every dollar of business COKE does, it only makes two cents.

That is why the stock stayed stagnant from 2000 through 2010. Although there were some fluctuations, COKE had a strong tendency to trade around $60 per share. The dividend has been flat at $1 per share (annualized) since the 1990s. COKE carries a wildly leveraged balance sheet–there’s over $622 million in debt. That is 12x the amount of money it makes in annual profits. A fair amount of debt would be 4-6x profits, and a high amount of debt would be in the neighborhood of 10x profits. The current profile of the company puts it at risk for excessive dilution or sky high interest costs if soda demand diminishes in the United States.

The best thing I can say about the company is that it does have the stable cash flows to service its debts. North American soda volume only declines by 2% or so per year, and COKE has used its dominant position in the United States to expand beyond distribution of just soda products–it also bottles Powerade, Monster Energy, Nestea, Fuze, and has recently begun distributing Dr. Pepper’s soda brands (but it still relies on Coca-Cola soda sales to generate 84% of its revenues).
And then, there are my valuation concerns. In the past twelve months, the price of Coca-Cola Bottling has climbed from $65 per share to $212 per share. The impetus for the rapid advance is that Coca-Cola announced that it was divesting of nine bottling operations that it owns, and Coca-Cola Bottling would be on the receiving end along with two other bottlers.

The transactions take place between 2016 and 2020, and analysts expect that COKE will double its profits from $50 million to $100 million over the next five years. Considering that the profits are only expected to double over five years, and the price of the stock tripled this year, you can probably already tell there is some overexcitement at play. For over 90% of the company’s publicly traded history, it has been valued between 16x earnings and 21x earnings.

The anticipation of this bottling acquisition has caused this company to flunk the back-of-the-envelope test. It makes about $5 per share right now. At $212, that is a P/E ratio of 42.4. In 2010, COKE is expected to making $10 per share. If It trades at 21x earnings then, the stock will be valued at $210 per share. Right now, the stock is at $212. The dividend yield is 0.5%, so you find much protection there. The hype surrounding this bottler right now has put the company in a position to deliver no capital gains over the next five years.

COKE is not the kind of company you want to buy. Perhaps if it had moderate debt and went on sale, it would be worthy of consideration. But none of those characteristics exist right now. For every dollar in bottling revenue generated, shareholders only get two cents. The $600+ million debt burden acts as a harsh anchor on future shareholder returns–it has to pay $20 million in interest payments over the next five years, yet only makes $50 million per year in profits. The current valuation of 42x earnings is drastically above the company’s historic fair value, and shareholders that buy in October 2015 will be quite disappointed with their returns when they take a peek at this holding in October 2020.